How Gordon Brown’s financial mis-management is hurting the pound

published 8 February 2008

This feature is part of our FREE daily Money Morning email. If you'd like to sign up, please click here: Sign up for Money Morning

It seems the Bank of England just can't please anyone.

It cut interest rates yesterday by a quarter point, which was basically what everyone had been expecting. But it hedged the cut with a warning that inflation looks like it could well spike higher in the months to come.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

https://cdn.mos.cms.futurecdn.net/flexiimages/mw70aro6gl1676370748.jpg

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

The suggestion that the Bank isn't going to panic and follow the Federal Reserve in throwing caution to the winds, sent the FTSE 100 plunging. It ended the day down by more than 150 points, at 5,724.

But at the same time, the pound also plunged against the dollar, despite clear implications that UK interest rates will remain well above those in the US for a long time to come. So what's going on?

The UK stock markets plunged yesterday because the Bank of England's comparatively gentle pace of rate cuts has disappointed traders. But the pound took a dive too, shedding almost two cents against the dollar. Judging by recent years, you would normally expect the promise of higher interest rates to prop up the currency rather than knock it down.

However, now it seems that currency traders are starting to pay less attention to interest rates and take more of a view on which countries are heading for recession. They are hoping that the rapid action (or blind panic) on the behalf of the Fed will make any US recession shorter and shallower.

I can't say I agree with this assessment as I've mentioned before, consumers are now in balance-sheet rebuilding mode. You can't force people to borrow more money if they don't want to, regardless of how cheap you make it, and you also can't force banks to lend if they are worried about their balance sheets too.

So for my money, cutting interest rates drastically at a time like this is pretty futile, and merely encourages higher inflation expectations.

UK or US: which would you rather invest in?

But it goes deeper than this. At the end of the day, if both the UK and the US are heading for recession (or in one, in the case of the US), which of those countries would you rather be invested in, assuming you had to have your money in one of them?

It's going to be the US every time. It might be running into serious trouble, but it's still the world's biggest and most important economy. So if you're an international investor who's feeling panicky about your investments in the West, then the US will still be the place you're most likely to divert assets to.

And of course, Britain is rapidly losing its reputation as a safe home for your money. The Northern Rock debacle took on whole new significance yesterday when the Office for National Statistics decided that £100bn would have to be added to the national debt to account for the taxpayers' funding of the bank. The ONS is basically treating Northern Rock as a publically owned company, like the Royal Mail. This makes sense, as of course, without the government propping it up, Northern Rock would have gone bust.

Now the move doesn't change much in practical terms, but it does look very bad for the government. It means that Gordon Brown's rule on sustainable investment has gone completely by the wayside. He always wanted to keep national debt to less than 40% of GDP, but this takes it to 45% - above the US.

The rules were of course, always a bit of smoke and mirrors to give economists and journalists a theoretical bone to chew over while Mr Brown got on with the serious job of squandering the country's money on health service middle management jobs.

Why sterling looks vulnerable

But as Ambrose Evans-Pritchard points out in The Telegraph, it's the reputational damage that "may prove to be the final straw for the UK's government bond market." He quotes Andrew Guy of ADG Capital Management as saying that "we are approaching the point where Asian and Middle East investors are going to charge a much higher premium for holding British sovereign debt. Once a government loses credibility, these investment shifts can happen with alarming speed."

If foreign investors lose faith in the government's ability to manage our economy, then they could rapidly pull out, hurting sterling even more, and driving up inflationary pressures. That would make the Bank's job even harder, and it's another reason why Mervyn King can't follow Ben Bernanke's strategy for staving off recession.

The dollar is still a hugely important global currency the US can still (just) afford to say, "the dollar's our currency, but it's your problem" to international investors.

Sterling, unfortunately, is entirely our problem.

Turning to the wider markets...

Enjoying this article? Why not sign up to receive Money Morning FREE every weekday? Just click here: FREE daily Money Morning email

US stocks snap losing streak

In London, the FTSE 100 closed down 151 points, at 5,724, and the broader indices were also lower. Yellow pages publisher Yell.com fell by over 15% after warning that tougher market conditions would hurt revenues. For a full market report, see: London market close.

On the Continent, the Paris CAC-40 closed down 92 points at 4,723. In Frankfurt, the DAX-30 was 113 points lower, at 6,733.

Across the Atlantic, US stocks closed in positive territory for the first time this week, despite poor retail sales data and below-expectation results from Cisco. The Dow Jones added 46 points to close at 12,247. The S&P 500 rose 10 points to end the day at 1,336. And the tech-rich Nasdaq, which tipped into bear-market territory early in the session (down 20% from its October peak), ended the day 14 points higher, at 2,293.

In Asia, the Japanese Nikkei fell 189 points to close at 13,017. Hong Kong was closed for the Chinese New Year.

Platinum hovers near all-time high

Crude oil futures continued to climb this morning, and were last trading 45c higher at $88.56. In London, Brent spot was at $88.95.

Spot gold was steady at $908.50 this morning. Platinum was at $1,840, just off yesterday's new all-time high of $1,850. And silver was at $16.77.

In the currency markets, sterling had edged slightly higher against the dollar after yesterday's falls and was trading at 1.9475 against the dollar this morning. Sterling was at 1.3442 against the euro, whilst the dollar was at 0.6900. And the dollar was at 107.56 against the yen.

And in London this morning, Chancellor Alistair Darling announced that the inclusion of Northern Rock's assets and liabilities on the government balance sheet would not affect fiscal policy, even though debt has national debt has risen above targets. Darling insisted that the rules set ten years ago 'made provision' for such a 'unique set of circumstances'.

Our recommended articles for today...

The six trends that will define 2008

- The second half of last year was like walking through a minefield, says Niels Jensen. But which hazards should investors watch out for in the year ahead? To find out why the US could, in fact, be the economy that suffers least from the crisis it precipitated, why you should expect a euro crisis and why the list begins, and ends, with the banking crisis, read: The six trends that will define 2008

Why gold is still undervalued

- Rising inflation, growing monetary problems... We've been here before - in 1974, to be exact. Back then, gold soared 73% and silver 84%. James Turk looks at whether history is about to repeat itself: Why gold is still undervalued

John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.